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MF Global Became Entangled In A Web Of Its Own Making, Shown Here

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Curious what went on at MF Global? Me too, I guess, in a professional capacity. You know who won't tell you? These guys:

One thing that we take very seriously here at Dealbreaker, starting now,* is the Visual Display of Quantitative Information, and this is known in the trade as "a graph made by lawyers." Quick quiz: how much money went from Commodities Customers to Affiliates? Is it:
(A) $251M
(B) $3,043M
(C) $246M
(D) $1,198M

Pretty sure it's indeterminate from that graph though guesses are welcome. I guess $23M is possible too. Anyway. The lawyers responsible for that monstrosity included it in a preliminary trustee's report on the demise of MF Global and I don't envy them the job since as the trustee puts it:

For three months our investigative team has worked to understand what happened during the final days of MF Global when cash and related securities movements were not always accurately and promptly recorded due to the chaotic situation and the complexity of the transactions.

So it's impressive that they tracked all of this, though annoying that they graphed it incoherently. And that this report, strangely, is about cash flows and not securities flows, which I guess is part 2, still to come. Like, I would think that sometimes cash was exchanged for securities? I dunno.

Anyway the report seems to confirm that it was margin calls on MF Global's portfolio of repo-to-maturity trades on European debt that mostly blew them up in the end, though I guess money's fungible and if everyone takes their money out then who's to say who precisely blew you up. But here's Bloomberg:

MF Global Holdings Ltd., the futures broker that filed the eighth-largest bankruptcy in October, faced a $310 million margin call on its final day that exceeded its market value.

Calls for payments tied to bets MF Global made on European sovereign debt increased Oct. 24 and continued through Oct. 31, the day the futures broker formerly run by Jon Corzine filed for bankruptcy protection, according to a report yesterday from James Giddens, a trustee overseeing the brokerage’s liquidation. MF Global had a market value of $198 million on Oct. 28 as it held $6.3 billion in European sovereign-debt trades.

Here's the trustee's report - you can go see a graph if you want but it's as terrible as the one above** so just look at this:

So on 10/31 MF had a $250mm in new margin requirements, on top of the $59mm that it hadn't gotten around to posting over the weekend, which was more than its market cap and, more relevantly, more than it had lying around either in unrestricted cash or in cash in segregated customer accounts that it had been gleefully looting for several days, so it filed for bankruptcy and that was that.

One thing to think about is what triggered those margin calls. Note that the variation margin changes were relatively small, though not nothing - MF Global's positions moved against it by $17mm during the course of its hell week. But the initial margin and "increase coverage" totaled almost $500mm. MF Global's contingency plan prepared before the downgrade predicted about a $215mm additional margin on a downgrade to below investment grade (see slide 16), which happened on October 27. This data is a little unclear but it looks like that margin call was bled in from October 26 to 28.

So the extra $250mm the next Monday was a little unexpected bonus that put MF over the top. LCH.Clearnet, which was clearing the repo to maturity trades, helpfully explains the purpose of its initial margin:

LCH.Clearnet Ltd only faces market risk in the event of the default of one of its clearing members. In those circumstances, it is faced with closing out, hedging or transferring the defaulter’s portfolio within a short period. In doing so, it may make a loss because of adverse price moves (i.e. the market risk may be realised). It is this market risk and this loss from which initial margin protects the clearing house. It does not need to cover adverse price moves that occurred prior to the default as this is already covered by variation margin.

It's not entirely clear to me why the repo counterparties would have thought this risk increased by $250mm over that last fateful weekend. Perhaps that call was just triggered by the final downgrade/bankruptcy filing - "well, heck, we're screwed so let's just ask for some more dough." Or perhaps after a weekend of MF Global freakouts, the repo counterparties had revised dramatically upwards their estimate of how painful it would be to disentangle their positions. In any case, it's not entirely clear to my highly untrained eye that these margin calls triggered the bankruptcy rather than the reverse. Perhaps we'll find out in part 2.

The SIPA Liquidation of MF Global Inc. [epiq]
Trustee's Preliminary Report [epiq]
The dramatic final days of MF Global [FTAV]
MF Global’s $310 Million Margin Call Exceeded Its Market Value [Bloomberg]
MF Global Trustee Traced $105 Billion in Cash Moves [Bloomberg]

* But excluding our own future efforts.

** Really! It depicts, like, three things in the same shade of gray. What would possess you choose a palette of green, orange, gray, gray, and gray?